Redefining Relationships

Citigroup’s much-vaunted full-service banking model has been put to the test in Latin America over these last three turbulent years. The bank has a long history in the region, dating back to the beginning of the last century, when it first opened a branch in Buenos Aires. But Citigroup’s commitment to Argentina – and Latin America as a whole – has come under enormous stress since the government defaulted in December 2001, an event that triggered the worst economic crisis in the country’s recent history.

Luckily for its shareholders, Citigroup has grown so large that upheaval in Argentina scarcely dents its profits. A decade ago, trouble in Latin America and in the US real estate market nearly drove Citicorp, as it was known then, to the wall. Today, it is the world’s biggest financial company, with a market capitalization of nearly $250 billion. It has millions of customers in more than 100 countries. It services consumers, corporations and governments around the world, providing them with almost every conceivable financial product.

Citigroup, born out of the merger of Citicorp and Traveler’s Group in October 1998, was conceived as a global financial supermarket offering everything from retail checking accounts to big-ticket investment banking deals. Its growth and diversification ensured that only a disaster of Biblical proportions would threaten its existence. As Citigroup grew in size, its exposure to Latin America has diminished but it always reassured clients and governments of its commitment to the region by pointing to its century of operations there.

Rethinking the Plan
But turmoil in Argentina and elsewhere in Latin America is casting doubt on the strength of this devotion as Citigroup cuts back credit lines, country limits, shuts branches and fires employees. Furthermore, change is afoot at Citigroup. Although the damage in Argentina is manageable, the losses are still quite large in dollar terms. Those losses exposed the perils of being so deeply embedded – once a favored term at Citigroup – in a country as a full-service bank. The concept of building a universal banking franchise is now being reevaluated.

Citigroup’s boss for Latin America and the Caribbean, a soft-spoken but steely-eyed Cuban-American called Jorge Bermúdez, says Citigroup, like many other international banks, is still adjusting to the aftermath of the Argentine crisis. “The commitment we have to our customer base across the countries has not changed. My view is that every time that you have an economic downturn or a market environment that becomes more hostile, prudent management leads you to reassess your business and your business model. That doesn’t mean you get out of a country. You look at the risks taking place in a market and adjust your risks to accommodate that new profile.”

This is music to investors’ ears. Steve Wharton, a vice president for investment at New York fund managers Loomis Sayles, says, “Historically, they have lent too much and not received enough of a return on that capital.” He says, “They are going through the entire emerging markets global relationship loan portfolio and trying to evaluate the relationships based on which ones are generating a sufficient return on capital.” Citigroup is not alone. All international banks are under unrelenting market pressure to extract more value from their balance sheets. Frank López, head of Latin American investment banking at Credit Suisse First Boston, says, “Clearly, banks are refocusing on how to use scarce capital and capacity for the best possible return on the investment for their shareholders.”

Most are slashing headcount, shutting offices, cutting exposure ? and dropping clients. They are reconsidering traditional, but low-margin lines of business like syndicated lending, which full-service banks once claimed would complement their push into higher-margin investment banking activities. Banks have slashed syndicated lending by more than two-thirds this year from its peak in 2001. Citigroup still ranks first in syndicated lending in Latin America this year, yet it lent just $1.6 billion through 12 syndicated loans through October, compared to $6.59 billion and 99 loans in 2001 according to research firm Dealogic. There is no public information on how heavily international banks have cut into bilateral lending to smaller, long-standing corporate clients that are not big enough, or do not spend enough with the bank to warrant further attention. However, anecdotal evidence suggests the cuts have indeed been deep. Investors such as Wharton applaud this ruthlessness. “I think that is very sensible. We have gone through this in the US. If you don’t generate enough money, [banks need to] downsize their extension of credit. They need to come up with more fees,” he says.

Beholden to Shareholders
Bank of America, JP Morgan, Santander Central Hispano, Banco Bilbao Vizcaya Argentaria as well as Citigroup, have either cut their exposure in the region, sold divisions or exited countries entirely. BBVA sold its Brazilian bank to local giant Banco Bradesco in a stock and cash deal. SCH has reduced its exposure to Latin America over the last two years, selling its weak Peruvian subsidiary to the country’s dominant bank, Banco de Crédito del Perú, for $50 million. It has scaled back in other smaller or slow-growing markets in which it had failed to establish much of a presence, such as Bolivia, Paraguay and Colombia, and instead concentrated its efforts in Brazil, Chile, Mexico and Venezuela.

Most banks’ performance has recovered after last year’s terrible results, but investors still wonder whether the rewards are worth the risk and volatility that doing business in dangerous markets like Latin America entails. In the third quarter of 2003, Citigroup reported $128 million net income in Latin America, compared to a loss of $109 million in the same period last year, including losses of $95 million in Argentina.

David Hendler, senior analyst for financial institutions at research firm CreditSights, says Citigroup’s new chief executive officer Chuck Prince barely mentioned Latin America in a November presentation to investors. Hendler left with the impression that Citigroup simply does not see Latin America as a priority for growth at the moment. “I think the priority is the US deposits [business] and doing a better job of cross-selling consumer products,” he says. “They are also more involved in proprietary trading, dealing with hedge funds and escalating and improving debt, equity and M&A activities globally. Everything else is being reassessed. I think they are asking themselves ?What are we doing down there, why are being so patient, is it worth it?’” Wharton at Loomis Sayles asks, “How many boom and bust cycles have we had down there?”

Client Selection
There is an obvious conflict between the banks’ commitment to a client needing support in tough times and their commitment to shareholders who demand banks manage risk conservatively when credit quality has deteriorated. The solution is to select its clients carefully, even if this means curtailing its claim to become thoroughly embedded in local markets. Says Bermúdez, “The reality is, and it applies to Citigroup, that we are a global bank and [although] we try to behave in all our markets as a local bank, we simply don’t have the branch networks that local banks have. Sometimes, we were selling our products to customers who may not necessarily value the products and services that Citigroup may bring, because we do not have the reach the local banks have. I want customers who value the products and services that Citigroup can offer and not just as a marginal player. I want to be a primary bank to our customers.”

However, satisfying shareholders and valued clients all the time is almost impossible. For example, Citigroup’s senior bankers have publicly applauded Brazil’s President Luiz Inácio Lula da Silva’s pro-market economic policies. Robert Rubin, Citigroup’s chairman of the executive committee, introduced Lula at a meeting of the Council on Foreign Relations in New York in September, praising him for steering “A wise and sensible course in response to meeting economic challenges.” In August, Stanley Fischer, vice chairman, said in a trip to Brasília, that Citigroup was committed to “significantly” expanding its presence in Brazil. Yet, Citigroup’s cross-border claims, or assets such as loans financed by deposits outside of the country, to Brazil are now half the $11.4 billion level in March last year, according to its SEC filings.

Clearly, this is not popular in Brazil where several big companies in financial distress and cut off from further financing, have had to restructure their debts. Heavily indebted long distance carrier Embratel, controlled by MCI, has struggled to return to health after restructuring its debt load. It is hardly surprising that Citibankers rarely turn up to drum up business from the company these days. Embratel CFO Norbert Glatt, who has used Citigroup for treasury services and bank lending, says, “Nothing has been happening lately with Citigroup. They are kind of distant, as if they were not here. Usually, [bankers] touch base to understand what the company is doing and what the company is doing next year. This is not happening any more.” 

Glatt says other international banks have gone even further than Citigroup. Germany’s Dresdner Bank has packed up and left Brazil, damaging relationships cultivated over years. “The support that we used to have directly in Brazil is coming from the US office, so we don’t have that attention that we used to have,” he says. Glatt says the cost of capital has risen, since there are fewer banks competing for fees. Clients are expected to pick up the cost of bringing investment bankers down from New York. “It is very hard when you have a local presence and the banker knows you and you trust him and suddenly you are not talking to this person any more. You are talking on the phone to someone in New York who does not know you well.”

Global Reach
However, Colombian brewery Bavaria is large and healthy enough to have no such problems. Bavaria is Latin America’s second-largest brewer, a serial acquirer of smaller breweries and an active issuer. Juan Carlos García, assistant treasurer at Bavaria, says its gargantuan size is one of the things he most values about Citigroup. “They say they have the biggest net income, and that is a little arrogant. But it is important for us as a corporate user,” he says. Size and profitability suggest durability, efficiency, success. He adds that, “Being a global bank, Citigroup can leverage off its global footprint. That has its advantages.” Bavaria chose Citigroup as bookrunner to lead-manage a blowout $500 million, seven-year 144a bond in October with joint lead-manager ABN Amro. An ability to offer local capital market products is increasingly important. However, García thinks Citigroup’s combination of global reach and local service could be refined. “The global presence with local abilities sometimes does not operate flawlessly,” he says. Clients say that while Citigroup’s senior management is highly professional, it is centralized, ponderous and unwilling to bend its rules or provide the highly customized service on offer at smaller, more agile local firms.

However, Citigroup and other US banks like Bank of America, have taken a very different approach in Mexico because it is a strong, investment grade economy that is closely intertwined with the US. Citigroup made a strategic commitment to Mexico in 2001, with its $12.5 billion acquisition of Banamex, one of the country’s biggest banks. Bank of America has bought a 24.9% stake in Grupo Financiero Santander Serfin, owned by SCH, for $1.6 billion.

Being Prudent
Julio de Quesada, director in charge of corporate investment banking for Banamex, says, “We haven’t cut clients as a result of the merger. Immediately after the merger we had to reduce some lines, not as a result of the risk profile of the client, but because the combination of Citibank and Banamex on some clients was too high and we had to reduce that to be prudent.” Banamex, which now accounts for 8% of Citigroup’s bottom line, reported a 27% increase in net income in the third quarter to $379 million, driven mainly by its corporate banking business. Citigroup manages its Mexican operations as part of its overall North American operations. However, executives at Mexican corporates complain of unreliable back office systems, slow response time and say Banamex bankers drawn from Citibank lack the experience and depth of knowledge about Mexico of Banamex executives.

If banks do focus on a narrower, but potentially more fruitful, range of relationships, it does not mean they have abandoned use of their balance sheets to buttress investment banking deals. There are times when banks will deploy their balance sheets to win a bond mandate. For example, British investment bank Barclays Capital put $1 billion of a $2 billion backstop facility behind a $2.5 billion two-tranche bond for Mexico in April, together with JP Morgan.

Analysts suspect Citigroup is moving further away from its full-service approach than it is stating in public. Hendler of CreditSights says, “I think [Citigroup] wants to have more of a Goldman Sachs/Morgan Stanley cachet. Those banks don’t have any on-the-ground presence in those countries. You don’t have to have all this loan capacity and all these retail branches. Argentina shows you it is troublesome. It is more hassle than it is worth.”  Bermúdez says, “Very specifically, we want to have relationships, which value Citigroup’s relationship in its totality, not just one component. One-dimensional customers are not the best uses of our resources.” 

Elephant Hunting
Goldman and other pure investment banking firms concentrate on “elephant hunting,” bagging a few large, but highly lucrative deals a year from the region. Senior officials at finance ministries and central banks around Latin America gave Citigroup low marks in LatinFinance‘s September poll of sovereign issuers. Citigroup ranked fourth overall and JP Morgan came first. Officials voted Goldman Sachs the investment bank with the most creative ideas and the most effective risk management solutions.

Carlos Guimarães, who used to run Citigroup’s investment banking effort in the region, has now taken on a new role as a counselor to Citigroup’s most  important clients in Latin America. He says, “The idea is to build a “trusted advisor” relationship with a select group amongst the key relationships in the region, so that you become their closest banker. It requires a lot of commitment, focus, time and effort.” Goldman Sachs excels at this and replicating its mystique will not be easy. Corrado Varoli, managing director and head of Latin American investment banking at Goldman Sachs, says the firm has stuck to firmly to its time-tested structure. “We spend a lot of time with core clients that we have defined as long-term clients and have strong senior relationships and focus on where we add the most value,” he says.

Citigroup’s mixed results in the debt capital markets this year may also have triggered the change. Research firm Thomson Financial says that Citigroup ranked as the second most active bookrunner of international sovereign and corporate bond issues in the region last year, after JP Morgan. It won 16 mandates worth $3.79 billion, giving it a market share of nearly 19%. It still ranked second to JP Morgan at the end of October 2003, with 15 bond deals worth $3.89 billion to its name but its market share dropped to just under 11%.

JP Morgan has outmaneuvered Citigroup in Mexico. Citigroup arranged just one $750 million, 10-year global bond for the sovereign with joint bookrunner Deutsche Bank in June, out of six issues totaling $7.38 billion the government has placed this year. But JP Morgan acted as joint lead manager on five Mexican sovereign issues worth $6.5 billion and Barclays Capital, a relative newcomer to the Latin American bond market, lead-managed a two tranche issue totaling $2.5 billion.

Citigroup has been left out in the cold in Brazil, too. It has lead-managed just one $750 million, eight-year global bond for the sovereign in September, together with Goldman Sachs. This was just one out of the six deals totaling $5.83 billion the government closed by mid-November. In comparison, Merrill Lynch lead-managed two bonds totaling $2.5 billion, followed by Goldman Sachs with $2 billion, CSFB at $1.5 billion and JP Morgan and Morgan Stanley with $1.33 billion.

As Citigroup and other international banks lower their profile in Latin America, they are creating opportunities for competitors once shut out of the market. As the big banks retreat, clients are turning deals over to smaller, less cautious firms and to large, full-service European banks trying to break into Latin America. South Africa’s Standard Bank has lead-managed $1.5 billion in deals in Brazil so far this year. It got most of these deals at the beginning of the year, when its far larger US and European competitors were deterred by the uncertainty and volatility in Brazil. And in October, Standard won a co-manager position with sole bookrunner Citigroup on Bavaria’s $500 million bond. Peter Wallin, senior vice president at Standard New York Securities Inc., has led this incursion into Latin America, which began only a few years ago with small fixed income deals in Central America and the Caribbean. He says, “We know that to develop relationships, we have to be there when others aren’t. Bavaria is an example where we have been helpful when the markets weren’t there.” 

Bear Stearns won a bond mandate from Petrobras, the national oil company in March. Petrobras had mandated Salomon Smith Barney for six out of its eight international issues in 2001 and none in 2002. Bear was sole bookrunner on the highly successful $400 million, five-year global bond in March that reopened the market for Brazil. Bear included a three-year put in the issue, which it marketed heavily to Brazilian and other Latin American clients. One senior Citigroup banker said at the time, “I have to admit it was a great deal. I take my hat off to them. They are a much smaller outfit than us. They don’t have our scale or credentials, but they got the deal done. Our guys spent all night trying to figure out how they structured it and got it done.” Bear had not lead-managed a bond for Petrobras since it brought a $200 million, three-year bond to market ten years ago. It won two more Petrobras mandates, a $500 million bond in June and a $250 reopening of the March bond in September. But Petrobras only mandated Citigroup, along with Spain’s BBVA, to lead-manage a $750 million securitization in May.

However, Citigroup did win the mandate to restructure Uruguay’s bonded debt in a historical transaction last May. It placed $5.3 billion in Uruguayan globals in a distressed exchange designed to relieve looming service payments. The deal was notable because this was the first time a sovereign had replaced its entire stock of bonds for new ones featuring collective action clauses designed to make them easier to restructure in the event of a financial crisis ( see “What CACs Lack”).

Citigroup and the other big New York banks are obviously right to reevaluate their role in Latin America, and change as the market changes ? even if they have to reduce their activities in the region and offend once-valued clients. But few bankers have any illusions that the big banks will remain on the back foot in Latin America forever. Wallin says, “Big banks have options. They can come and go and do business elsewhere, and in a quick period of time they can come back.”

Some relationships may take longer to rekindle than others. Embratel’s Glatt says that in future he won’t take seriously banks that have skipped out of the region when the going got tough. “I know I can’t rely on them being here. From the company’s point of view, we like long-term relationships. We try to develop partnerships, because you can rely on a partner. If [the banks] are not here [and then come back] you don’t know if they are going to disappear again. I have to look at the banks working with us. I believe in reciprocity,” says Glatt.

Yet the international full-service banks like Citigroup, with their vast resources of capital, their technological edge, global market access and regiments of highly-trained investment bankers, will be back in force as soon as Latin America returns to growth, risk declines ? and issuers need to access the international capital markets. Perhaps they will even be talking about ambitious plans to embed themselves in the local markets again.LF